No Such Thing As An Opinion!

August 18, 2011

To Simon Johnson, former chief economist of the IMF: You are shockingly incorrect!


Today, The NY Times published an article by Simon Johnson, former chief economist of the International Monetary Fund and author of the book 13 Bankers.

The article is titled "A Second Great Depression, or Worse?"

After reading what he wrote, it would be an understatement to say I'm shocked!

Looks like I'll have to add more room to my Logic's 'Liars' list!

And what a coup this is...the former chief economist of the IMF!

He writes: 

"With the United States and European economies having slowed markedly according to the latest data, and with global growth continuing to disappoint, a reasonable question increasingly arises: Are we in another Great Depression?

The easy answer is 'no' — the main features of the Great Depression have not yet manifested themselves and still seem unlikely. But it is increasingly likely that we will find ourselves in the midst of something nearly as traumatic, a long slump of the kind seen with some regularity in the 19th century, particularly if presidential election-year politics continue to head in a dangerous direction.

The Great Depression had three main characteristics, seen in the United States and most other countries that were severely affected. None of these have been part of our collective experience since 2007."

The following paragraph is the source of his flawed logic:

"First, output dropped sharply after 1929, by over 25 percent in real terms in the United States (using the Bureau of Economic Analysis data, from its Web site, for real gross domestic product, using chained 1937 dollars). In contrast, the United States had a relatively small decline in G.D.P. after the latest boom peaked. According to the bureau’s most recent online data, G.D.P. peaked in the second quarter of 2008 at $14.4155 trillion and bottomed out in the second quarter of 2009 at $13.8541 trillion, a decline of about 4 percent."


So, he's claiming the following:

Although it's increasingly likely the US will experience a long slump "nearly as traumatic" as the Great Depression, it's "unlikely" the US is currently experiencing (or will experience) another Great Depression, because the main features of the Great Depression aren't evident.

In support of this, he cites the drop in GDP:

After adjusting for inflation, GDP dropped by over 25% after 1929.  By comparison, GDP dropped by about only 4% between the 2008 GDP peak and the 2009 GDP bottom.

There are serious flaws with this logic!


1) First, he isn't clear what period of time the 25%+ drop refers to.

I looked at the tables he refers to.  Among the years that succeeded 1929, 1933 had the lowest GDP.  There was a 26.7% drop in GDP between 1929 and 1933.

So what Simon's done is this:  He's compared a four year period (1929 to 1933) to a one year period (Q2 2008 to Q2 2009)!

I'm not sure that's an appropriate comparison.  I do get his point:  That both comparison periods relate the top point to the bottom point.  But the two periods of time cover very different lengths of time.

If you were to compare equal lengths of time and look at the period Q2 2008 to Q2 2012, who's to say that the GDP of the USA won't fall further by Q2 2012?  (Although I don't expect it the fall to approach 26.7%...but that leads to a second criticism I will make later).

Also, many aspects of government regulation (and the economy in general!) vastly differ between 1933 and 2008, further limiting the usefulness of the comparison.

In addition, you could reverse things: 

Since he examines a one year period after the 2008 peak, why not also examine a one year period after the 1929 peak?

If you do that, you see that real GDP dropped only 8.6% from 1929 to 1930 ($87.3 to $79.8 billion). 

That 8.6% drop (1929 to 1930) is much closer to the 4% drop (2008 to 2009) than is the 26.7% drop (1929 to 1933) he references!

Now, I'm not claiming that one should necessarily compare time frames of equal length.

I'm claiming that one should not necessarily compare the GDP top to bottom time period regardless of the length of that time frame!

Simon doesn't even mention that he compares two very different time frames!


2) I've saved the best for last. 

The most serious flaw with his GDP comparison is this:  It's like comparing apples and oranges!

It is absolutely ridiculous to be looking at the final GDP figures because GDP is not at all reflective of the organic economic ability of the country!

Why is GDP not reflective of the country's economic ability?  Because GDP includes the effect of borrowed (and printed) money!

Without controlling for those factors, it's absolutely absurd for the former chief economist of the IMF to be comparing 1933's GDP to 2009's GDP!

My previous article explains:

"There's an organic level of goods produced by a country.  Meaning, if the government didn't take steps to borrow money through a stimulus package, the country would create a certain amount of goods and services.

During the recession, the organic amount of goods and services produced by the USA plummeted by several tens' of percentage value (depending on what your reference period is).

Now, imagine that the US government can borrow money through a stimulus package, as Obama did.  Imagine that the government takes that money, and spends that money directly, in many ways.  For example, look at 'shovel-ready' projects: The money directly hires construction workers, who directly produce goods, who (by purchasing materials for concrete) indirectly create concrete, and raise the GDP.

The increase in the GDP was completely artificial.

It had nothing to do with the production ability of the country itself, and everything to do with borrowed money.  Because that money is not free, and needs to be repaid, its effect on GDP means nothing.

Imagine this scenario: You are self employed in sales.  You are not selling enough to cover your monthly expenses.  Eventually, you deplete your entire savings.

Instead of going bankrupt, you borrow money on your credit card.  As a result, you are able to continue making sales, but you are still unprofitable, still selling less than is required to cover your overhead.

Note, however, that the sales you are making, regardless of how unprofitable they are, still count as sales!  They still show up in your own GDP figures!

Therefore, your GDP is higher than it otherwise would be, but it is all artificial, because the sales were completely a result of borrowed money that needs to be paid back!"


So, my point is this:

If you exclude money that the government pumped into the economy during 1929 to 1933, and if you also exclude money the government pumped into the economy during 2008 to 2009, it's very plausible that there was a comparable drop in GDP between the two periods.

But Simon doesn't do this!

He refers to the small 4% drop in GDP between 2008 and 2009, yet mentions nothing about the fact that a further GDP drop was prevented by borrowing money heavily!


How Would Simon Respond?

I suspect Simon might respond by stating something like the following:

"Why does it matter whether government borrowing prevented GDP from dropping more than 4%? After all, the end result is that it dropped by only 4%, meaning that people's wealth hasn't dropped much.  That is entirely consistent with my argument that we haven't entered a situation similar to the Great Depression. 

By contrast, after 1929's Great Depression people's wealth did drop quite a bit, and hence their situation is quite different than the one we find ourselves in now."

Here's how I would respond to that:

Although people's wealth hasn't yet directly dropped much, that came at a price:  Government debt increased massively.  And that has consequences, because it's the people that have to pay that debt.

Remember, Johnson didn't just say that current economic conditions don't resemble the Great Depression, he said it seems "unlikely" that future economic conditions will resemble the Great Depression.

But the 2008-2009 economy, sans government borrowing, likely did resemble the Great Depression.  Borrowing money just kicked the can down the road.  What do you think is going to happen when that money is paid back?  Huge spending cuts and tax increases will be necessary just to achieve a small budget surplus to begin paying back the debt.  As a result, how could GDP not then plunge?

Look at what's been occurring the past few days...the massive recession related borrowing itself contributed to S&P's downgrade of the US credit rating, sparking a huge stock market loss of wealth during the past two weeks.

There is no indication that the government is going to borrow yet again to provide for yet another stimulus plan.


Conclusion

How did Simon Johnson become chief economist of the IMF?

I don't know about you, but I find it frightening to think that he may have had a huge role in helping shape international policy! 

I actually believe he's probably a
very intelligent individual!  I just think that he's probably not intelligent enough to warrant the position of chief economist of the IMF!


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